Tech start-ups fight shy of going public

It is not often these days that investors have the chance to send the shares of a tech company to a huge premium on its first day of dealings. Such acts of exuberance do still happen.

In an echo of the dotcom craze of the 1990s, buyers snapped up shares in Fitbit, pushing them 52 per cent above their offer price as the manufacturer of wearable technology made its debut on the New York Stock Exchange. But it is a ritual that is played out all too infrequently in what has become known as the second great tech boom.

The issue is not that investors are reluctant to buy into the latest online prodigies — ventures such as Uber and Airbnb. It is that fewer entrepreneurs want to go public. US tech companies have raised just $3.5 billion from initial public offerings this year, down from $10.5 billion during the same period in 2014.

Viewed over the longer term, the revulsion from stock markets is even more striking. Tech IPOs now raise less money, adjusted for inflation, than in the early 1990s, according to research by Andreessen Horowitz. When it comes to the number of deals done, you have to reach back even further into the past, to the 1980s when the likes of Apple and Microsoft were listing their shares.

The main reason is that tech ventures are staying private longer. Instead of doing IPOs, they are tapping funds from “late stage” venture capital investors. So far this year, companies have raised $20 billion through such private offerings.

Their reluctance to go public explains the increasing ubiquity of what are termed “unicorns” — privately held entities whose equity has been ascribed a valuation in excess of $1 billion. At the beginning of June there were 61 of these fabled creatures in the US, valued at a collective $212 billion.

It is easy to see why tech founders want to stay private. Most prefer to get on with growing their businesses, rather than courting institutional investors and dealing with the bureaucratic demands of the quarterly earnings cycle.

Some argue this is not a bad thing from the stock market’s perspective either. Far too many immature businesses floated during the 1990s tech boom, burning merrily through investors’ cash in the fruitless search for viable revenue models before collapsing. Instead of frittering away Joe Public’s money in pursuit of the next Facebook or Google, why not leave it to hardened venture capital groups, backed by wealthy investors whose shoulders are broad enough to bear the inevitable periodic loss?

It is not as if the latest wave of tech companies require the industrial quantities of cash that only public equity markets can provide. The cost of digital technology has plunged since 2000. Initial funding rounds for tech start-ups have more than halved in size over the past decade.

There are, however, two reasons to worry about the way the tech market has developed. The first is that it is not only hardened venture capital that is funding rounds. Increasingly, mutual and hedge fund money is doing so. Conscious that more value creation is taking place at the pre-public stage, they are muscling in.

Fierce competition inevitably erodes standards. One way this expresses itself is in higher valuations, which means that losses can be heavy when they occur.

The risk was illustrated in the recent case of Fab, an online retailer that essentially folded in 2014 after burning rapidly through nearly $300 million, much of it raised at a $1 billion valuation

A second concern is that a predominantly private structure excludes the price-signalling that only public equity markets can provide. Valuations are essentially set by a small coterie of professional investors, moreover one whose job prospects are inextricably linked to the perceived success of investments into which it has sunk its cash.

Short-sellers may be unpopular with tech founders. But arguably they helped to check the irrational exuberance that inflated the dotcom bubble before 2000. The current tech boom is clearly different to the last one. Many businesses have proven and fast growing revenue models and, in any case, the amounts being invested — $48 billion last year — are well below the $71 billion staked (in 2014 dollars) in 1999.

But excessive reliance on private markets could lead to more capital than necessary being wasted on ventures badged hopefully as “disruptive” by their founders. It is one reason why a few public offerings by tech companies other than Fitbit might not be a bad idea.

Financial Times